What is neoliberalism and why does it matter?

In the first of a two-part series, Aidan Regan traces a history of neoliberalism, and shows why its supremacy as explanans for all economic activity is based neither on the rigour of its methods or the predictive power of its hypotheses, but on a simple moral argument about the superiority of the individual over the collective; the private over public.


This article shows why the underlying assumptions governing neo-classical economics and its political expression in neo-liberalism are so flawed that any attempt to re-construct a market economy based on the same assumptions are bound to fail. Markets are a sub-system of society and an institutional mechanism to coordinate economic activity in a political system called capitalism. This varies across time and space depending on country specific institutions (i.e. Irish capitalism is different to Finish capitalism). Markets are political constructs and cannot exist without active political re-construction. It is not possible to separate the "state" from the "market". Neo-classical concepts of a "free market", "state intervention" and "market failure" are only possible if we accept the assumption that "markets" are a natural phenomenon that exists free from politics. This is only possible if we assume certain characteristics about human psychology that are a-historical and anti-social. Thus, the most important critique of neo-liberalism is a moral critique of how it conceptualises human intentionality. Despite claims to the contrary, neoclassical economics is essentially a normative theory.

Capitalism and market based exchange is not possible in the absence of trust, collective association and values of mutual reciprocity.  These are the conditions of social integration that make capitalism possible. The neo-liberal assumption that it is natural for individuals to have pre-determined motivations premised on the "selfish" pursuit of money means that public and private institutions are designed to condition this type of behaviour. In turn, this produces economic cycles of boom and bust rather than assumed "market competition". If a bank is designed to incentivise the maximisation of short-term gain for shareholders rather than strategic investment in productive labour activity why should we be surprised that banks speculate recklessly? Neo-classical assumptions about rationality and market behaviour are internally contradictory and logically flawed. It is not the most efficient way to organise an economy and it is certainly not a way to build the necessary social and democratic foundations for sustainable living systems. We need to redesign political economic institutions so that they are premised on what it really means to be human. The first way to do this is challenge the libertarian philosophical assumptions guiding contemporary economic discourse.

Where did the politics and economics of neo-liberalism come from?

After the Second World War there was a general consensus amongst political and economic elites that the "laissez faire" doctrine of letting markets rip was a complete policy failure. This may have been a pragmatic decision. It was hardly private capital that was going to rebuild Europe after the devastation incurred by the war. The backdrop to the war was a massive economic recession, huge inflation and growing unemployment. These were central conditions that enabled the emergence of a far right political movement in Europe, another policy lesson that has been lost on contemporary elites. The Marshall plan, aimed at rebuilding Europe, was the beginning of a coordinating policy discourse that legitimated significant public investment and state involvement in the economy.

The next 30-40 years were premised on a variety of economic theories that set the terms of reference as to what was an appropriate role for the "state" in the economy. Such theories mainly included "Keynesianism" and "welfare state economics". They all agreed that the state had an important role to play in mitigating the worst effects of the private market, particularly insuring citizens against market risk. It was widely accepted that citizens required social protection against unemployment, old age, sickness etc. Labour markets were to be de-commodified through social security and a variety of social rights were embedded in health, education and pension provision. The introduction of universal suffrage put in place a political mechanism whereby capitalism could be democratised. The state was essentially about managing this tension between capitalism and democracy.

This compromise did not last very long. In fact, viewed from a long-term historical perspective it was a relatively brief period in capitalist development. But, importantly, it was a period that re-considered the role of politics and public institutions in managing capitalism. The state was central to resolving problems associated with "wage, work and welfare". These were considered central to economic development and too important to be left to private market exchange. Political parties, as collective actors in government, utilised administrative power in the interest of a fair wage, full employment and social security. The benefits gained should not be underestimated. It showed that politics when utilised in the interest of the common good can mitigate the worst effects of market economies. Some countries went further than others, particularly the social democratic economies of Nordic Europe. The legacy effects were not without its problems, not least its institutionalisation of a "male bread earner" model of social policy.

From theory to global practice

From 1970 the debate on the appropriate role for "state" quickly changed. In response to the inflationary impact of the oil crisis, the Keynesian compromise of full employment was quickly shattered. Labour was blamed for excessive wage demands. The state and public expenditure came to be considered wasteful and damaging to the efficiencies of private market activity. The terms of the debate on what was the "appropriate role for the state and public institutions" in a capitalist economy was set by neoliberal theorists such as Milton Friedman, Fredrich Hayek, Geroge Stigler, James Buchanan and Alan Peacock. Hayek published his seminal text on the Road to Serfdom in the 1940s. It was a damning critique of ‘state interference in the economy’. It was a relatively unknown piece until Friedman popularised its ideas in Capitalism and Freedom. These ideas became a reality with the election of Margaret Thatcher in the UK and Ronald Reagan in the US. Politics enabled an economic theory to become a global practice.

This unholy alliance between a neoclassical economics (centred on controlling the money supply through interest rates and independent central banks) with a philosophical-moral text in Austrian-Hungarian libertarian theory should not be underestimated. The welfare state was now considered less the ‘socialstaat’of German social democracy but an institution of self-seeking politicians and civil servants who act in the interests of rent seeking interest groups. Any form of collective organisation such as trade unionism, regulation and public governance was considered antithetical to the freedom, creativity and efficiency of private markets. The state was corrupt, expensive and a drag on the creativity of autonomous markets.

In fairness, there was good reason to be critical of the state. It had become an administrative jungle and there is no doubt that bureaucratic inefficiencies were rampant. The legacy of totalitarianism and state dictatorships was lingering in many aspects of public administration. But, the critique was focused less on these problems than the "role of the state" and "politics" in a system that was democratic. Given that neoclassical economics works on the assumption that all individuals are self seeking, it was assumed that all public policies are designed by self seeking interest groups. This favours "particular" interests over the "general" interest of markets. Thus, neoliberalism became popular less for its economic arguments but its moral arguments about the superiority of markets, the individual over the collective, private over public.

This new school of economic thought set the rules as to what was the appropriate boundary between the "private market" and the "state". It was by defining this boundary that neoliberals set the political agenda for the next two decades. Everything had to be justified on the basis of an acceptable "market intervention". The state could only "intervene" if there was market failure. Thus, it could maintain law and order, private contracts or competition laws because these were seen to correct market failure. The state could enable and facilitate the functioning of perfectly efficient market economies. Welfare economics was quickly subsumed under this logic. It a mechanism to coordinate in the interest of markets.

The myth of making markets free from state intervention!

It was not that long ago when attempts to remove slavery were considered a unnecessary intervention in a free labour market.  Today, many make strong arguments as to why international legislation criminalising child labour is an unnecessary regulation that would lead to an exit of capital from "developing economies".  Similarly, it is standard to hear economists and employers arguing against environmental regulation (control of emissions, pollution standards, health and safety) as an intrusion upon the freedom of business. Or, think about Brian Cowen’s argument, supported by most of the media, economic consultants, builders, developers and banks when he publicly stated that "it is not the role of the state to interfere in the housing market".

Labour regulations on working hours, sick leave, parental leave, contracts of employment, dismissal and minimum wages are all considered unnecessary interventions in the labour market by organised business groups. IBEC roll out their ‘experts’ to show that any attempt at regulating the labour market in the interest of workers will lead to job losses.

Trying to define a ‘free’ market is a futile exercise. What constitutes a "free" market is ultimately a political decision. A failure in one market might be considered a success in another. If the primary purpose of market activity is to increase GDP by at least 4 percent every year then anything that achieves this (regardless of whether it is a housing boom, export expansion or the consumption of milky bars) is a good thing. Pollution is good if it increases GDP. Growth and capital accumulation is all that matters. In reality, most economies want a particular type of growth and it is generally based on making stuff and selling it in ‘free international markets’. But, what if the objective was to minimise income inequality? Some might consider (as I do) high levels of income inequality as a ‘failure of the market’. Should the state step in and re-distribute? According to neoliberalism it should not. The neoclassical market is not supposed to create an equitable distribution of income or resources. Thus, given that the ideal model says it is OK, well then it is OK!

Furthermore, given that the "ideal free market" without "failure" or "state intervention" is premised on competition you would probably expect neoliberals to break up monopolies. They do. They despise monopolies, particularly those in the public sector. Therefore, competition policy (as the primary legislation of the single European market) is designed to correct market failure by breaking up large semi-state companies in telecommunications, transport, and energy etc. Does this mean that the state is allowed to break up the monopoly of Tesco? Absolutely not, this would not be a correction of market failure; it would be state intervention in a private market.

For the neo-classical economists market failure equates to economic failure. What might make really good economic sense (i.e. a public investment bank, economic planning to ensure the productive use of capital, investment in job creation) to those with common sense is a failure and inefficient state intervention by neoclassical economists. Public policy is and has been determined by all of these assumptions for the last 20 years. It fails to recognise that markets are a politically constructed institution with significant normative implications for society. A perfectly competitive market that is ‘free’ has more in common with Plato’s cave or Catholic purgatory. It is an idea!


Part two - Who is Homo Economicus? - will be published tomorrow



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